This article was originally published on ETFTrends.com.
By Robert Ross, author of "The Sin Stock Anomaly: Collect Big, Safe Profits with These 3 Hated Stocks"
Let’s face it: You probably think you pay too much in taxes. That’s especially true if you’re trading dividend-paying stocks at a rapid clip.
See, if you hold a dividend-paying stock for less than 60 days, its dividend payments are considered unqualified for tax purposes.
Unqualified dividends are taxed at your ordinary tax rate. Depending on your income, that could be as high as 37%. Qualified dividends , on the other hand, are taxed at your long-term capital gains rate. Depending on your tax bracket, that could be 0%, 15%, or 20%.
That might seem like a minor difference, but it can add up to thousands of extra dollars.
Maximizing Your Dividend Income
Let me walk you through an example of how much additional money you can get with a little bit of patience.
First, imagine an investor named Jeff. Jeff is a long-term, buy-and-hold, dividend growth kind of guy. He knows the market will dip and rally over the short term. But he doesn’t let the dips bother him much.
Instead, Jeff puts a lot of thought into the stocks he buys—only investing in safe and reliable dividend-paying stocks . Then he puts his head down and watches his money grow.
Now imagine a second investor named Tim. Tim is a lot more skittish. He buys stocks on a whim, never knowing if they’re “good” or not. And he has a bad habit of selling at the first sign of stock market trouble.
In 30 years of investing, Tim has never held a stock for more than 50 days. Jeff and Tim are both single. And they both make $80,000 per year. So here are their tax rates:
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Short-term capital gains/ordinary income (including unqualified dividends) = 22%
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Long-term capital gains (including qualified dividends) = 15%
Now, both guys were bullish on McDonald’s (MCD) way back in 1989. So they each bought $10,000 worth of McDonald’s shares.
True to form, Jeff held on to his shares until August 2019. Tim, however, has traded his McDonald’s position erratically. Let’s see how they did…
“Buy and Hold” Pays Off Big Time
After holding his McDonald’s shares for 30 years, Jeff’s $10,000 investment had grown to $632,986.
Jeff eventually sold his shares in August 2019. After taxes, he made a $538,038 profit. That’s because Jeff reinvested his dividends . And, when it came time to sell, he paid the lower, long-term capital gains rate of 15%.
As you can imagine, Tim was not so lucky. Any time McDonald’s share price dipped a little, Tim would panic sell… then buy back in. Despite trading in and out of McDonald’s a slew of times over 30 years, Tim still did okay. His original $10,000 investment grew to $303,069.